Eric Harrington – Bailouts? We don’t need no stinkin’ bank bailouts…

As I watch the talking heads and economists all wring their hands and speculate as to the best way to spend the $825 billion (where they got this number I’ll never know) stimulus package, I must confess, I am completely flummoxed as to why we need to give one penny to the Banks..

Banks already do not loan money they posses. They create money out of thin air up to roughly 9 times the amount they have in assets..It’s called Fractional Banking. The figure of 10% apparently was established pragmatically over hundreds of years dating back to the Gold Smiths, who recognized they only needed 10% of the gold and silver entrusted to them actually be in hand at any time to cover normal withdrawal patterns… So when the banks freeze credit today, they are simply saying that with all the bad debts they hold, their verifiable assets (to which this ratio applies), can’t support creating more loans under current regulations, and they have to dramatically restrict credit.

So why give them money they can spend as they wish? All they have been doing is using that CASH to buy troubled companies and pay dividends and bonuses. The simple solution is to temporarily suspend the fair value accounting standards for financial institutions, to limit bank’s artificial write-downs on the value of their mortgage related securities, for a while. In simple terms, Ignore the Asset to Debt requirements specific to Mortgage holdings. It effectively has the same value as giving them bailout money, but with a primary difference.. They can’t use it to pay executives, or investors, or buy companies, they can only use it to LOAN money to entities outside their company like you and me, and through which they can then generateearnings to pay all those other people. You know, the free market way…

Why am I (I admit, it was the congressman who brought it to my attention), and Oregon Congressman Pete Defazio (Congressman’s DeFazio’s Alternative)the only ones discussing this? It accomplishes all the value of a bailout with a simple stroke of a pen, and none of the potential for abuse, as long as normal regulatory oversight is in place..…

Uh oh! We agree! “Mark to market” is a poorly done half-execution of a good idea, post Enron, supposedly to keep companies from leveraging inflated assets. It doesn’t however, need to be elminated. We simply need am optional “plan B valuation”, which would typically be applying a standard (for the asset class) cap rate of cash flow. Companies could choose (and disclose) which valuation method they used, and why. So, if someone had $100 mil of mortgages that were performing as expected, but there just wasn’t a market to sell those mortgages right now, the holder could use a capitalization of the cash flow and book the asset at that value.

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Actually, banks lending more than assets CAN and SHOULD work fine when lenders lend, and lend only. This leverage allows deposit returns higher than otherwise, profits higher for bank shareholders, and loan rates lower without significantly impacting HISTORICALLY PRICED risk.

When things got haywire was when Glass Steagall was repealed, and lenders, who often have an all-knowing God complex anyway, thought they could do OTHER businesses well.

Initially, because the additional banks as asset purchasers drove prices up (just like the loosening of underwriting criteria in mortgages drove prices up with more “qualified” people entering the market) due to relatively more purchasers (banks or home-buyers in the analogy), bankers looked smart and drank some more Koolaid of their own making.

Stocks since the repeal have moved from from 8X earnings to 20X earnings (rough #s) creating an asset bubble that was and is unsustainable for anyone looking for yield as an owner of a stable business, not a speculator. 20X earnings was “justified” by the “we’ll grow into the valuation” mantra.

Additionally, lenders became so diluted focus-wise that they don’t underwrite loans very well, anymore.

Reinstate Glass-Steagall, make lenders lend ONLY (keep them out of other businesses, including other ownership, investment banking, insurance and real estate), and they can leverage 10X and that should be relatively safe and sustainable.

Actually, banks lending more than assets CAN and SHOULD work fine when lenders lend, and lend only. This leverage allows deposit returns higher than otherwise, profits higher for bank shareholders, and loan rates lower without significantly impacting HISTORICALLY PRICED risk.

When things got haywire was when Glass Steagall was repealed, and lenders, who often have an all-knowing God complex anyway, thought they could do OTHER businesses well.

Initially, because the additional banks as asset purchasers drove prices up (just like the loosening of underwriting criteria in mortgages drove prices up with more “qualified” people entering the market) due to relatively more purchasers (banks or home-buyers in the analogy), bankers looked smart and drank some more Koolaid of their own making.

Stocks since the repeal have moved from from 8X earnings to 20X earnings (rough #s) creating an asset bubble that was and is unsustainable for anyone looking for yield as an owner of a stable business, not a speculator. 20X earnings was “justified” by the “we’ll grow into the valuation” mantra.

Additionally, lenders became so diluted focus-wise that they don’t underwrite loans very well, anymore.

Reinstate Glass-Steagall, make lenders lend ONLY (keep them out of other businesses, including other ownership, investment banking, insurance and real estate), and they can leverage 10X and that should be relatively safe and sustainable.

10X is the standard from time immemorial. AS I have said in the past, bubbles occur when those in control change the time tested rules of finance. In the Dot com bubble it was investing in start-ups that could not clearly indicate where revenue would come from. In the housing bubble, it was eliminating the Lenders exposure through derivitives, which then allowed the lenders to relax underwriting standards (who cares when it’s not their money). Stocks are similar in that their values are grossly inflated. In the past, investors simply wouldn’t buy inflated stocks and the value would go down.

A big problem is investors have gotten used to unrealistic returns, and so there will always be someone ready to hotwire the system to accomodate until proper regulation is in place and enforced. Thats the real issue, not only do you need the regulations, but then you need properly funded enforcement and that is the final barrier the Republicans throw up against regulation. Just hold the budgets hostage.

Nothing will change until reasonable people (I hope the majority but sometimes I wonder) stop voting for the Lunatic fringe called the Republican Party.

When I was at UCLA studying investing in the 1980s, multiples on the US stock market were 8-12, and thought the Japanese were nuts for investing at 18-20X earnings. Eventually, their bubble burst and they sucked wind for decades. Now, 18-20X is standard for boring, mature US companies. That just wrong. If one can see profits doubling in 12 months then sustaining that after that, I can support that kind of valuation, but, that’s almost impossible for mature companies.